Wednesday, 6 April 2011

How to dispose of the national debt in two or three years.


The national debt could be paid off in no time at all simply by, 1. creating extra money, 2, buying back the debt, and 3, counterbalancing the inflationary effect of this by raising taxes.

To the extent that those in receipt of cash in exchange for debt do not take their money out of the country, this process would involve no standard of living cut for the average household because the whole process consists of nothing more than re-shuffling assets and liabilities between different types of household. However, a standard of living hit WOULD occur to the extent that those in receipt of cash in exchange for their government debt take their newly acquired cash out of the country. The latter would reduce the value of the country’s currency on foreign exchange markets, which in turn WOULD involve a standard of living hit: but nothing like the hit that resulted from the credit crunch.

On the other hand if a significant proportion of the world’s larger countries adopted the “buy back” policy at the same time, there would be almost nowhere for the above cash to go, thus the standard of living hit would be minimal.


Mike Norman recently advocated a debt removal idea here and here which is much the same as the debt removal idea I set out here. Essentially the idea is “create new money and buy back the debt”, or “pay it off with printed money”.

Mike argues for this idea on the grounds that cash and govt debt are very similar in nature. Thus there would be little inflation resulting from paying off the debt with printed money. That is, govt debt is essentially a form of money.

The latter point is true in that both monetary base and govt debt appear on the liability side of central banks’ balance sheets. The point is also true in that govt debt near maturity is essentially the same as cash or monetary base.

However, the two are different in that govt debt pays interest, whereas monetary base pays little or none. And this is significant: the easier it is to find an interest yielding home for cash, the more “cash + interest earning deposits + plus government debt, etc etc” the private sector will hold. Put another way, if govt debt is removed, that makes it more difficult to obtain interest on cash and near cash investments, which in turn will reduce the amount of cash and near cash assets the private sector wants to hold. (And for those who want to see the latter point put in Warren Mosler terminology, see “1.” below.)

The result is that a “print money and pay off the debt” policy would result in the private sector attempting to dissave cash, the effect of which would be stimulatory and (if the economy is at capacity) the result could easily be excess inflation. But this is not an insuperable problem: the problem can be solved by counterbalancing the stimulatory effect of the “buy back” with some sort of deflationary measure like increased taxation, of which, more below.

Two “by the ways”.

At this stage, two incidental points need making. First, I’ll assume a closed economy for the moment: that is, it is assumed that debt holders do not take the cash they acquire as a result of the buy back out of the country.

Second, this article is no more than “thinking aloud” on the subject of paying off the debt. Ideally, a large number of factors need to be quantified before embarking on a quick “pay off the debt” policy. And identifying, never mind quantifying all those factors is way above my pretty little head.

Why pay off the debt?

An obvious and very poor reason for paying off the debt is as follows. One portion of the government / central bank’s liabilities (the portion that pays interest) is called “debt”. In contrast, the portion that pays little or no interest (the monetary base) is not commonly called “debt”. Plus the word debt has negative overtones. For the bulk of the population, that is the only reason for wanting to reduce the debt. And of course it is a nonsensical reason.

There are however some better reasons. See second last paragraph here.

Also, none of the arguments FOR government debt stand inspection. See here.

Increasing taxation.

As pointed out above, the stimulatory effect of a large scale debt buy back would have to be counterbalanced by some sort of deflationary measure, like increased taxes. But this tax increase, while it might be a political or psychological problem, is not any sort of economic problem. In particular, the tax increase would not reduce household living standards (assuming a closed economy).

Put another way, there is no good reason why the buy back should necessitate a reduction in aggregate demand. And no change to AD means no change to the average household income. (Indeed, the problem if anything is avoiding an excessive INCREASE in demand.)

As distinct from household INCOMES, let us now consider household ASSETS. But be warned: the following section is abstruse!

Private sector assets.

Assume the economy is at capacity – (an assumption which will be relaxed later). This assumption means that prior to repaying the debt, cash and other household financial assets must have been at a level which induced households to spend at a rate which brought full employment. If those assets are expanded or made more liquid, household spending will rise too much (as pointed out above). The effect would be inflationary.

Put another way, additional spending at full employment results in NO ADDITIONAL SPENDING in real terms. Or to put it yet another way, the additional cash in private sector hands that produces this additional spending is in a very real sense TOTALLY WORTHLESS!!!

The latter scenario is a bit like owning a pile of $100 bills, 10% of which are obvious forgeries. The obvious forgeries are just not worth anything: the authorities might as well confiscate them (let’s say via a ploy called “tax”).

It might seem from the above argument that in buying back debt, a portion of private sector assets (in the form of government debt) has been converted from being in some sense “real” to being “illusory”. And the latter point, if valid, would mean that the buy back WOULD involve a reduction in private sector or household assets.

However, the reality is that government debt is, and always has been to some extent an illusory form of wealth and for reasons very similar to those set out just above.

Take an economy which is at full employment and is stable (i.e. not entering or recovering from a credit crunch or anything else traumatic). Assume there is a chunk of government debt that is about to reach maturity. When it DOES reach maturity, the debt is converted to cash, at which point private sector assets are too liquid. Demand would become excessive, unless some sort of deflationary measure is taken. One possibility is to roll over the debt. Another is to raise taxes, i.e. confiscate a portion of private sector assets.

In short, when debt is converted to cash, private sector assets become too liquid REGARDLESS of whether the reason is bonds reaching maturity or whether a buy back policy is in operation. And in both cases, the part illusory nature of the bonds has to dealt with by some sort of deflationary measure.

Incidentally, the above argument relating to the part illusory worth of government debt is over simple in that government bonds do not suddenly acquire all the characteristics of cash on the date of maturity. In reality, such bonds GRADUALLY acquire the characteristics of cash as the date of maturity approaches. But never mine: hopefully the above over simple argument gets the point across.

The conclusion reached at the end of this section is as follows. The additional tax needed to counterbalance the stimulatory effect of a buy back appears to each household to involve a confiscation of some of each households assets. However, the reality is that all that is being confiscated is a portion of household assets that cannot be spent anyway: a portion which is essentially worthless.

An economy not at capacity.

It was assumed at the start of the above section on private sector assets that the economy was at capacity. It was then argued that if private sector assets are made more liquid, there is a danger that excessive spending takes place.

An alternative assumption is that the economy is at less than capacity. On this assumption, the argument is much the same.

Of course, where an economy really is at less than capacity it is obviously desirable to RAISE spending. But the decision to raise aggregate spending is separate from the decision to buy back the debt. Thus to consider how to go about buying back the debt assuming a CONSTANT level of capacity utilisation is perfectly logical.

And on the basis of the latter assumption, the argument about private sector assets is much the same. That is, briefly, the volume and/or liquidity of private sector financial assets cannot be increased, because to do so would be stimulatory: it would change the level of capacity utilisation.

An open economy.

It was argued above that a buy back has no effect on living standards, if those in receipt of cash in exchange for their government debt are not able to take their money out of the country. In contrast, in an open economy, these cash rich entities might well take their newly acquired cash out of the country. As a result, the value of the relevant country’s currency on the foreign exchange markets would decline. And that would represent a real standard of living cut for residents of the country.

On the other hand, if a significant proportion of the world’s larger countries adopted the buy back policy at the same time, it would be difficult to find an alternative and better home for the cash. So the standard of living cut would be relatively small.

Moreover, it seems that most voters are happy to take a standard of living cut if that helps reduce the national debt. So let’s go for the above “buy back the debt” policy!


The national debt can perfectly well be bought back with new or printed money. It would probably be necessary to counteract the stimulatory and/or inflationary effects of that policy with tax increases. However, contrary to appearances, such taxation would not reduce household incomes. Nor would it reduce the real worth of household financial assets (though persuading households of the latter point would be a difficult!)

The buy back policy would involve a standard of living cut if a significant proportion of those in receipt of cash in exchange for their debt took the cash out of the country. On other hand, if a significant proportion of the world’s larger countries adopted the buy back policy at the same time, there would be almost nowhere for this cash to go, thus there would be no significant standard of living cut.

There are no big logical or strictly economic problems involved in buying back the national debt with new money or printed money. The problems are almost entirely psychological or political.


1. See the parent, child and business card analogy in “Soft Currency Economics”. As Mosler puts it, “The parent might decide to pay (support) a high rate of interest to encourage saving.”



  1. You can't take cash out of the country. You can only exchange it with somebody who wants the cash rather than the cash they currently hold. And they're only going to do that if they want to spend it on something - given that cash would otherwise be worthless to hold.

    Only the name on it changes. It doesn't go anywhere.

    And again this would be part of a policy shift away from maintaining an 'import subsidy'. I wouldn't envisage 'paying back the debt' until I'd embedded zero rates in the economy (ie deficit spending with currency rather than bonds).

    I'd think that shifting to zero rates would be where the currency move would happen and you would get a shift in real incomes. But you should also get a stimulation and a reduction in the deficit as you get more private spending and more and more repatriation of currency held as reserve by foreigners.

    From the depressed state we're all in at the moment, I'm struggling to see a downside to getting rid of new bonds. It seems like a way of causing spending from stocked reserves that also reduces the deficit.

  2. Neil, When pounds sterling are sold, the names of the owners of those pounds change: that’s true. But also the pound loses value on the foreign exchange markets. And that in turn means, as I pointed out above, a standard of living hit for UK citizens. “Taking cash out of the country” probably wasn’t the best bit of phraseology I have ever used. But my basic point remains valid (I think!).


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